Christmas week could be sluggish for stocks

Stock investors might get a few stocking stuffers, but not much in the way of big gains in the four-day week after Christmas.

Stocks gained very slightly in the past week but ran out of steam Friday, as markets digested the GOP’s massive tax reform package and headed into the long holiday weekend. The market is often higher in the final days of the year and into the early part of the new year, in what is known as the Santa rally.

“Just based on the action we’ve seen in the last couple of days, the market seems to be comfortable it’s priced in the tax cuts,” said Peter Boockvar, chief market analyst at the Lindsey Group, adding the final week of the year is a wild card. “I think it’s clear, it’s priced in. You’re up 20 percent this year.”

But some Wall Street strategists were upping 2018 forecasts for the S&P 500 and earnings, based on the tax cuts and the boost to capital spending that could come from the legislation signed into law by President Donald Trump on Friday. Credit Suisse now has a target of 3,000 for the S&P. The corporate tax rate will fall to 21 percent from the current 35 percent starting in 2018.

Scott Wren, global equity strategist at Wells Fargo Investment Institute, said he will be changing his earnings forecast and outlook for the S&P 500, based on the anticipated tax boost to earnings.

“The assumptions that we initially made — which were a 23 percent tax rate, 30 percent interest deductibility and then 50 percent on cap ex expensing — those were just not aggressive enough. The tax rate is lower, and you have 100 percent expensing. You do the math and it pushes earnings up. We’re going to make some adjustments here,” he said.

Still unclear is how much the market has priced in of the potential earnings bump.

Bank of America Merrill Lynch reported that equity fund outflows for the week ending Wednesday were the highest in more than three years at $ 14.5 billion. There were record levels of outflows from small-caps and value funds, two areas that should benefit from the new 21 percent corporate tax rate, so the selloff suggests that some investors may believe the tax cuts are priced in.

BofAML global investment strategist Jared Woodard said the outflows do not mean there will be another rush for the exit this week, and he is expecting a positive environment for stocks in January.

“It gets obviously really quiet next week, trading wise. We think in terms of the first quarter there’s plenty of room in the short term for a continued rally, but we think the 10-year yield is the main driver to watch,” he said. “If you see that break above 2.5 or if you see 3 percent later in the quarter, we argue it has a dramatic impact.”

The 10-year Treasury was surprisingly volatile in the past week, making a sharp leap by Wednesday from the mid 2.30 percent range all the way up to 2.50 percent. It was at 2.48 percent Friday afternoon. Bond strategists say some of the action had to do with year-end positioning, and the yield could move lower again in the coming week. Yield moves inversely to price. But as the yield rose, there was focus on the tax bill, and how much debt it could add on top of the debt the government already has to issue.

Woodard said for the stock market, some of the outflows may have had to do with investors taking profits because they don’t expect huge gains for companies from the bill.

But higher yields and a more aggressive Fed seem to be everybody’s overriding worry for next year.

“The risks are still the Fed making a mistake, raising rates too much,” said Wren. “The Fed could be a headwind for the market.” The Fed has forecast three interest rate hikes for next year and is limiting the amount of Treasury and mortgage securities it buys by another $ 10 billion in January. At the same time, the European Central Bank also is cutting its asset purchases in half starting in January.

“Each day that goes by is getting closer to a change in the flow in liquidity Jan. 2,” said Boockvar. “There’s a $ 45 billion reduction of QE [quantitative easing asset purchases] from the Fed and ECB Jan. 2. Whether people care about it, maybe not, but maybe this choppy action shows they do.” He said European stocks have been lagging, and German CPI is reported Friday. A pickup in inflation is one thing that could change expectations for central bank activity in the coming year.

Art Cashin, director of floor operations at UBS, said the volume on Friday was very light and trading could be very muted in the final week of the year. “I think it’s probably going to be flattish,” he said, noting now that the tax bill has passed and Congress has left, the market won’t get much of a boost from Washington.

“You’ll have to take a bit of a cue from Europe,” Cashin said. “They’re having some problems after the Catalan election. There are fears of another Brexit.” Catalan separatists did well in local elections, raising concerns of another effort by the region to split from Spain.

As for the U.S., there is consumer confidence data Tuesday, pending home sales Wednesday, and advance economic indicators and jobless claims Thursday.